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Monday, 2 November 2015

The Financial Instability of the Norwegian Economy

Just how the mountain of debt created in Norway is compatible with "financial-" and "economic stability" is a question Norges Bank (Norway's central bank) and the government should have pondered decades ago before they made the citizens of one of the richest countries on earth among the most indebted in the world (e.g. here).

An ever changing money supply, which the central bank ultimately controls, might be able to keep the CPI around 2.5% over time. In a progressing economy, an increase in the money supply (remember money is created as debt) would be necessary to push prices up as economic progress tends to put downward pressure on prices. However, in facilitating debt creation, monetary policy creates a whole other set of problems such as asset bubbles (e.g. housing, the stock market and a range of corporate bonds) and the transfer of purchasing power from savers to borrowers. And, as we all saw for ourselves in 2008, asset bubbles are incompatible with "financial"- and "economic stability".

The monetary policies orchestrated by the central bank and the government of Norway are therefore simply incompatible: you cannot achieve both economic stability and continuous price inflation at the same time and over time. This incompatibility of monetary policy was pointed out generations ago by economists (e.g. F.A. Hayek in Monetary Theory and the Trade Cycle published in 1933) - it's nothing short of financial- and economic instability by design.

Yes, Norges Bank and the government of Norway have certainly managed to create their coveted price inflation (i.e. a reduction in purchasing power), but with it they've fueled a range of asset bubbles while ordinary bank savers are watching with despair a real drop in the purchasing power of their savings (ordinary savings accounts now pay less than 1% interest while the money supply has been expanding more than 5x that rate). Common sense tells us that when extravagance is rewarded and thrift is penalised, something has gone astray and bad things must follow - economic instability.

It remains the faulty goal of most central banks and governments across the world to achieve both of these competing objectives at the same time. Therefore, in order to achieve "economic stability" and an item that ought to be high on any government's agenda, namely sound economic growth, we need to first begin by correcting what lies at the very heart of the problem: unsound and faulty monetary policies.

2 comments:

I have a fundamental question regarding the 2,5% inflation target. Why 2,5%? Why not aim for zero? Economists today say: "No, because that is too close to deflation, people will postpone their consumption to later on when prices are lower.. Yada yada". This is utterly, utterly wrong. Think about it, would you really wait to buy an iphone if the price _maybe_ fell 0.1% at the end of the year? It could in fact also increase to 0.1%! Oh, wait; Consumer electronics actually falls in price continuously (and products even gets better every year), and still a lot of demand of electronics, no? This is GOOD deflation cause of increasing production efficiencies, which again enables more people to afford to buy. In this case of deflation everybody get richer, and there is no problem with falling prices at all!

Lets do an analogy to see this stupidity.If you have cancer, you loose weight. Here, cancer is the underlying problem, and loosing weight is the seen effect.

Deflation is like loosing weight. Government and economists falsely believes that if you loose weight it must mean you have cancer. Or even worse, they believe if you loose weight - this will lead to cancer!

To exemplify:"Since we had deflation during the great recession, we should avoid deflation. Deflation was the problem and made a real mess"

Transfered to the losing weight analogy:My grandfather had cancer and lost a lot of weight. The weight loss made him weak and caused a lot of complications. If we increase our weight by 2,5% every year, we will prosper and have no cancer.

You must look at the CAUSE of deflation. If you in fact have cancer, gaining weight is not fixing the underlying problem. And stuff that falls in price every year (because of higher efficiency) is no danger to the economy. You can in fact demand MORE products and services than before, you get richer and also spurs more growth through your higher purchasing power! If this is true, what is then the case for inflation? Wouldn't you be poorer, all else equal? LESS products and services to buy? But do you race to the stores to spend all your cash on payday, because it will be 2.5% more expensive next year? Boosting the economy? Didn't think so. It dwindles away on your savings account, and with negative real interest rates this makes you poorer each year. Perhaps you chase yield and take on more risk than is good for you. Junk bonds or stock market with already high P/E's. Or maybe you buy real estate. Real estate can only go up, right? Central bankers should take their hat and leave, they do more harm than good.

Central banking induced inflation benefits no one except the ones that get the money first. It's like playing monopoly and only handing out the 2,5% extra money to one player every round. Who do you think will be relative richer in the end?

It is this terrible money system that make the rich richer and the poor poorer. We should FIX THIS DIRECTLY rather than making another wrongdoing through higher taxes on "the wealthy" - which hurts the productive capacity of so many legit businesses that is responsible for increasing our living standards.

Thank you for excellent commentary. Well put and couldn't agree more on 2.5% price inflation target. Worse yet, price inflation targeting and "economic stability" are incompatible - you cannot achieve both at the same time and over time.

I have in due course concluded, absent the abolition of central banking (which would be ideal), that the only monetary policy that should be in place is one ensuring the money supply (and base money) never changes, i.e. the implementation of an inelastic money supply.